To save the euro, let Greece go – 31st March 2015

Another deadline is approaching for Greece and its fate within the eurozone. The tripwire is April 9, when the next loan repayment instalment of €450m is due to the International Monetary Fund. So far, the European Central Bank has been willing to keep Greece afloat through its weekly approval of emergency liquidity assistance, but this is only available to banks that are considered solvent. If Greece defaulted on its IMF debt then the country’s banks could no longer qualify for ECB emergency funding. They would close, the government would have to impose exchange controls and the economy would come to a sudden and painful halt.

There are historical precedents, from Argentina and post-war Greece itself, that indicate how the economy would eventually recover. But it would probably involve a temporary period of high inflation as a new currency was introduced and devalued. This is not the outcome that the Greek people want or that Germany and the other eurozone members want to provoke. However, the alternative carries high long-term risks for the survival of the single currency and little prospect of a sustainable growth path for Greece. It is a classic case of being caught between the Scylla and Charybdis of Greek legend.

On one side, the Greek government of Alexis Tsipras wishes to impose its democratic mandate to escape from the conditions of the bailout agreed between the previous government and the IMF, ECB and the EU. On the other side, Germany and other members of the eurozone fear that relaxation of those terms for Greece would not only undermine any future ECB conditionality, but also weaken the domestic political support for other governments in the single currency that have implemented tough austerity measures that are only now beginning to show positive results. These double-edged economic and political risks of giving in to Greek demands have stiffened the other eurozone members’ resolve.

Greece was embroiled in lengthy talks at the weekend with lenders that are demanding the implementation of reforms before they will unlock about €7.2bn in bailout funds. It is tempting to portray these negotiations as a game of chicken. Each side believes that the other has too much to lose from a breakdown to allow that to happen. But this may be a miscalculation by Greece for three reasons.

First, the eurozone economy outside Greece appears to be recovering, either because of the ECB’s programme of quantitative easing or because of the impact of supply-side measures taken by governments, or both. There is little urgency or appetite for a change of direction. Second, the eurozone governments and banks are better prepared than in the past for a Greek exit from the euro. Banks are better capitalised and Greek debt is a smaller portion of their reserves now than two years ago. Finally, the rise of anti-euro protest parties in Spain, France and even Germany has shifted the debate from dry economics to fiery politics. The willingness of other electorates to foot the bill for the generous retirement benefits and weak tax collection in Greece has worn thin.

This Greek tragedy will not end happily for any of the protagonists. If the past is any guide, negotiations will continue until the last minute and concessions on the Greek side may enable the eurozone leaders to “extend and pretend” one more time. But, if so, this will not be the final act. The unfolding drama has exposed the fundamental weakness of imposing a common currency on such disparate societies without the central mechanisms either to enforce constraints on budget deficits or to trigger large inter-country subsidies. If the eurozone is to prosper under a single currency over the next decades, the Greek threat will have to be removed – not because Germany insists, but through the solidarity and resolve of all remaining members.